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Statistical physics challenges economics

Feb 12, 1999

Economists like to think that stock markets are rational,
but recent research has shown that irrational behaviour has a significant effect on the
market.
Thomas Lux of the
University of Bonn in Germany and
Michele Marchesi of the
University of Cagliari in Italy have created a computer model of a financial market that splits traders into two groups,'fundamentalists' and
'noise traders'.
The former make decisions based on realistic predictions of the
'real world' value of companies.
Noise traders,
on the
other hand,
act on trends and
patterns in the
market.
The model,
which is based on ideas from statistical physics,
shows that large numbers of'optimistic' and
'pessimistic' noise traders destabilizes the
market.
The model can also explain the
extremely high value of Internet stocks (Nature397 498).

Once the
balance between 'fundamentalists' and
noise traders is breached the
market
becomes more volatile and creates boom or bust cycles. For example,
Amazon.com is
now worth over $30 billion,
30 times its predicted revenue this year,
despite never
making a profit. Lux and Marchesi suggests that the increasing numbers of
'optimistic' noise traders investing in Internet stocks is making the market unstable. As
more and more noise traders follow this trend,
companies such as Amazon find their
share prices pushed far above their true worth.